By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Thursday was a lively day for currencies. The initial focus was on the British pound and the Bank of England’s monetary policy announcement but investors quickly turned their attention to the new highs in oil and are now looking forward to Friday’s U.S. retail sales report. While the dollar traded higher versus the euro, Japanese yen and Australian dollar, it's down for the week against most of the major currencies. The pullback is primarily a function of profit taking after last week’s strong gains. But Friday’s consumer spending report will determine whether the reversal continues. Nonfarm payrolls is traditionally one of the most important pieces of U.S. data but these days, spending -- not job growth -- is a problem. Retail sales contracted 2 out of the last 3 months but with wages on the rise, spending is expected to have recovered strongly in April.
The problem is that the forecast for retail sales is very high and Johnson Redbook reported a decline in spending last month. Economists are calling for 0.8% rise in retail sales, which would be the strongest increase in 11 months. The recent uptick in gas prices will help lift the value of purchases, but we’re not sure that it will be enough to meet expectations. A weak number will confirm that the U.S. economy is slowing down and guarantee that the Federal Reserve will leave interest rates unchanged in June. A strong number may help the dollar but any gains will be limited by the fact that one positive report will not be enough for the Fed to hike next month. Producer prices and the University of Michigan index are also scheduled for release but the focus will be on retail sales. On a fundamental and technical basis, the dollar is still a sell on rallies until we have a string of positive U.S. economic reports.
Meanwhile, oil prices hit a 7-month high above $47 a barrel at the start of the North American trading session after the International Energy Association said it expects non-OPEC output to fall by a larger amount and global demand to rise more than expected. That drove USD/CAD to fresh lows but the gains were short-lived as oil prices backed off. According to IEA, a series of production outages along with a pickup in demand will cause a “dramatic reduction” in oil stocks in the second half of the year. Given the recent trend of global economic data, we are not sure if this forecast is accurate, particularly since Iran will continue to flood the market with supply and the fact that Saudi Arabia plans to increase production. Meanwhile, the supply disruptions caused by the wildfires in Canada and attacks in Nigeria are expected to be short-lived. So we are still looking for a top in oil and a stronger recovery in USD/CAD.
Sterling ended the day sharply higher against the U.S. dollar despite Bank of England Governor Mark Carney’s tough warnings about the consequences of Brexit. It was no-holds-barred for the central bank Governor who said it was BoE's responsibility to communicate Brexit risks, which include a possible recession. While they are not making any judgments about the long-term impact of Brexit, he said there’s room to lower interest rates if needed. There’s no doubt that he will be criticized for political meddling but his warning about recession and a “sharp drop” in the pound indicates that he sees more pain than gain if the U.K. decides to leave the European Union. The central bank also lowered its 2016-2017-2018 GDP forecasts, saying that inflation will rise to 2.1% in the second quarter of 2018. Despite these warnings and downgrades, sterling recovered its initial losses quickly as investors view these updates as a strong reason for Britons to vote to remain in the Union.
The sharp decline in Eurozone industrial production prevented EUR/USD from extending its gains. However the contraction in manufacturing activity should not be surprising because it is consistent with the declines reported in Germany and France. Eurozone first-quarter GDP numbers are scheduled for release Friday and a rebound in growth is expected after a subdued fourth quarter. The sharp increase in Germany’s trade deficit in March was positive for growth but spending has been weak, which could subtract from Q1 activity. For the time being, EUR/USD is holding above its 20-day SMA, which means the uptrend is intact. But if it closes below this month’s low of 1.1358, then further losses are likely.
Thursday's worst-performing currency was the Australian dollar, which fell hard against the greenback. Softer economic data and a new 2-month low in Iron ore pressured the currency. Consumer inflation expectations eased to 3.2% from 3.6%, the lowest level in 8 months. This explains the Reserve Bank’s recent decision to cut interest rates and leaves the door open to additional easing. Rating agency Moody’s also warned that Australia’s worsening budget deficits are credit negative. All of these factors put significant pressure on AUD, which saw sharp losses against all of the major currencies. In contrast, the New Zealand dollar held steady versus the greenback after Finance Minister English promised to bring forward spending from 2017 to 2016. The jolt of fiscal stimulus reduces the chance of more easing from the RBNZ.
Although USD/JPY ended the day off its 109.43 high, it's worth noting that a former Ministry of Finance official who is apparently close to Bank of Japan Governor Kuroda predicts that the central bank will ease in June or July. The economy is weak and the strong yen has been no help. Many economists expected the BoJ to add stimulus last month and when it passed, the expectations were pushed out to the summer. So his forecast is not out of line with market expectations.